Price Quotation Basics on Interest Rates Futures

- extracted from Don Chances Introduction to Derivatives

Types of Interest Rates Futures

Eurodollar and Treasury Bills Short Term

Treasury Note Intermediate-term
Treasury Bond Long term

Treasury Bills and Eurodollars Futures

Treasury bill and Eurodollar contracts trade on the International Monetary Market (IMM) of the
Chicago Mercantile Exchange. They are the most actively traded futures contracts on shortterm money market instruments.

Treasury Bills

Treasury bills are auctioned each week and normally mature in 91 days. T-bills are purediscount instruments, and the discount is quoted on a 360-day basis.

Price Quotation: Although the futures contract allows delivery of a 90-, 91-, or 92-day bill, the
contract price is always quoted based on a 90-days bill.

Suppose a T-bill futures contract is priced such that the discount is 8.25.
The IMM quotes the bill price as 100 8.25 = 91.75. This is called the IMM Index.
Therefore the future price should be 91.75.
However, that is not the actual price at which you trade the contract and thus is not
the real futures price. The actual future price per $100 is given by the formula:
F = 100 (100 IMM Index) (90/360)

For example, if the IMM Index is 91.75,

F = 100 (100 91.75)(90/360) = 97.9375

The standard size of a single contract is $1million face value of T-bills; thus the
futures price is $979,375.
The purpose of assuming a 90-day bill in the formula is that it implies that one-point
move in the IMM Index converts to a $25 change in the future price.

EURODOLLAR FUTURES

A Eurodollar is a dollar deposited in a foreign bank or foreign branch of a U.S. bank. The
primary Eurodollar interest rate, called LIBOR for London Interbank Offer Rate, is considered
one the best indicators of the cost of short-term borrowing.

A major difference between T-bills and Eurodollars is the manner in which their rates are
interpreted. The T-bill is a discount instrument and the Eurodollar is an add-on instrument.

The Eurodollar futures contract is based on a three-month Eurodollar time deposit, which is a
loan made by one bank to another. The contract is for $1 million face value and is quoted by
the IMM Index method.

Price Quotation Basics on Interest Rates Futures

T-bill : For example, the quoted rate is 10 percent for both 90-day T-bills and
Eurodollars. Then the T-bill price per $100 face value would be 100-10(90/360)=97.5
and that yield would be (100/97.5) 365/90 1 = 0.1081. Thus the investor puts down
$97.5 today and receives $100 in 90 days.

Eurodollar : For a Eurodollar deposit of $97.5, the interest would be figured as

$97.50(0.1)(90/360)=$2.44, thus the investor would get back $97.5+$2.44=$99.94 at
expiration. The return would be (99.94/97.50) 365/90 1 = 0.1054.

T-bills will not, however, yield more than Eurodollars in general because T-bills
have no credit risk while Eurodollar borrowers could default. The Eurodollar rate
would simply be quoted higher.

Treasury Notes and Bonds

Treasury note and bond contracts, which are traded on the Chicago Board of Trade (CBOT),
are virtually identical except that

there are three T-note contracts that are based on 2-yr, 5-yr, and 10-yr maturities while

the T-bond contract is based on Treasury bonds with maturities of at least 15years that
are not callable for at least 15 years.

Thus, the T-note contracts are intermediate-term interest rate futures contracts and the Tbond contract is a long-term interest rate futures contract.

Price Quotation: T-bond futures prices are quoted in dollars and thirty-seconds of par value of
$100. For example, a futures price of 93-14 is 93 14/32, or 93.4375.

Conversion Factor (P.315-316, txt bk):

The T-bond contract is based on the assumption that underlying bond has an 8
percent coupon. The 8 percent coupon requirement is not restrictive, however. The
CBOT permits delivery of bonds with coupons other than 8 percent, with an appropriate
adjustment made to the price received for the bonds.

The adjustment is based on the CBOTs conversion factor system. The conversion
factor, CF, is defined for each eligible bond for a given contract. The CF is the price of a
bond with a face value of $1, coupon and maturity equal to that of the deliverable bond,
and yield of 8 percent.
The conversion factor system is designed to place all bonds on an equivalent basis
for delivery purposes. If the holder of the short position delivers a bond with a coupon
greater than 8 percent, the CF will be greater than 1. The short will then receives more
than the futures in payment for the bond.
To determine the invoice price the amount the long pays to the short for the bond
multiply the CF by the settlement price on the position day. Then the accrued interest from
the last coupon payment date until the delivery date is added.

Invoice Price = (Settlement Price on position day)

(Convertion

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Price Quotation Basics on Interest Rates Futures